How Compound Interest Works in Investments
Luis Ángel Rodríguez, General Director of BBVA Asset Management México, explains that compound interest involves reinvesting earnings to increase the invested capital over each period, thus generating greater returns.
“Instead of withdrawing the gains and reinvesting the same amount each time a term ends, the yields are added to the capital and reinvested together period after period. This causes money to grow exponentially, not linearly,” Rodríguez points out.
An example of this is investment funds, where returns are automatically reinvested, constantly increasing the capital. For Cetes, you can take advantage of compound interest if, at the end of the term, you manually reinvest the resources or activate the automatic option on platforms like Cetesdirecto.
According to Rodríguez, “The benefit of compound interest is accelerating an investment so that gains generate increasingly larger benefits over time.”
Compound Interest in Debts
Compound interest is also found in products like credit cards and loans that capitalize interests. If a debt uses this scheme, at the end of each period, interests are added to the outstanding amount and generate more interests in subsequent periods, causing the debt to grow exponentially.
Credit cards are a prime example, as interests are calculated on the unpaid balance. In contrast, fixed-payment credits do not apply compound interest. Usually, late payment fees or penalties are charged, but the debt does not grow under the compound interest principle.
The National Commission for the Protection and Defense of Financial Services Users (Condusef) recommends carefully reviewing the terms and conditions of financial products to identify the type of interests applied.
Key Questions and Answers
- What is compound interest? Compound interest is the process of reinvesting earnings to increase invested capital over each period, leading to greater returns.
- Which investments use compound interest? Investment funds are a prime example, where returns are automatically reinvested, constantly increasing the capital.
- How does compound interest affect loans? Credit cards, which calculate interest on unpaid balances, are a prime example of exponential debt growth through compound interest. Fixed-payment credits, however, do not apply compound interest.
- What does Condusef recommend? The National Commission for the Protection and Defense of Financial Services Users (Condusef) advises carefully reviewing the terms and conditions of financial products to identify the type of interests applied.
